With banks getting ready for the year-end regulatory stress testing, it is worth looking at what stress testing is and, more importantly, what it is not.

Typically, stress-testing models simulate adverse conditions to evaluate if a system/structure can survive abnormal circumstances. For banks, the objective of regulatory stress testing, also known as Comprehensive Capital Analysis and Review (CCAR), is “to assess whether the largest bank holding companies operating in the United States have sufficient capital to continue operations throughout times of economic and financial stress …”

Passing CCAR is important as low grades create a negative perception and accompany regulatory restrictions. However, passing stress tests can also create a false sense of security because of what it is not.